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Indias Foreign Investment Policy:

Achievements & Inadequacies

Amitendu Palit

July 2009

Asie VAsie Visions 18isions 18

Centre Asie Ifri


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The Institut Franais des Relations Internationales (Ifri) is a researchcenter and a forum for debate on major international political andeconomic issues. Headed by Thierry de Montbrial since its foundingin 1979, Ifri is a non-governmental and a non-profit organization.As an independent think tank, Ifri sets its own research agenda,publishing its findings regularly for a global audience.

Using an interdisciplinary approach, Ifri brings together political andeconomic decision-makers, researchers and internationallyrenowned experts to animate its debate and research activities.With offices in Paris and Brussels, Ifri stands out as one of the rareFrench think tanks to have positioned itself at the very heart ofEuropean debate.

The opinions expressed in this text are the responsibility of the

author alone.

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All rights reserved, Ifri, 2009

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Contents

INTRODUCTION ..................................................................................... 2

OPERATIONAL FEATURES..................................................................... 3

GRADUAL EVOLUTION .......................................................................... 6

THE UNFINISHED AGENDA .................................................................. 14

CONCLUSION...................................................................................... 20

Appendix 1..............................................................................................22


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Introduction

Indias conscious shift in the early 1990s from an inward-lookingdevelopment strategy to a globalized market-based approachresulted in significant changes in its foreign investment policy. Till the1990s, the policy was heavily restrictive with majority foreign equitypermitted only in a handful export-oriented, high technologyindustries. Outward-oriented reforms radically changed suchperceptions with foreign investment policy becoming progressively

liberal following steady withdrawal of external capital controls andsimplification of procedures.

Enabling policies have resulted in aggregate foreigninvestment into India increasing from US$103 million in 1990-91 toUS$61.8 billion in 2007-2008.1 India is variously identified as one ofthe most attractive long-term investment locations.2 It can attractmuch larger foreign investments given its distinct virtues of largedomestic market, rising disposable incomes, developed financialarchitecture and skilled human resources. But transforming thepotential to actual will depend significantly upon further liberalizationof its foreign investment policy.

This paper outlines salient aspects of Indias foreigninvestment policy and traces the evolution of the same. It follows upwith a critical evaluation of the policy from a political economyperspective. Structurally the paper is divided into three sections withthe first and second dealing with features of the investment policy andits evolution and the third attempting to outline the unfinished policyagenda and the constraints on further liberalization from a politicaleconomy perspective.

Amitendu Palit is a visiting research fellow at the Institute of South Asian Studies(ISAS) at the National University of Singapore (NUS). Comments and feedback on

the paper may kindly be sent to [email protected] [email protected] . The views expressed in the paper are entirely personal

to the author. Usual disclaimers apply.1

Total of foreign direct investment and foreign portfolio investment. Estimatesobtained from the Handbook of Statistics on Indian Economy, Reserve Bank of India(RBI), Table 159, p. 264. Available at: http://rbidocs.rbi.org.

in/rdocs/Publications/PDFs/87541.pdf [Accessed on June 5, 2009].2

Observations from UNCTADs World Investment Report(2007) and Foreign DirectInvestment Confidence Index of A.T. Kearney. See Foreign Direct Investment inIndia: Policies and Procedures, Government of India, p. 6; available at:


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Operational Features

Foreign investment comprises foreign direct investment (FDI) andforeign portfolio investment (FPI). The two categories areconceptually distinct in several respects. FDI represents a long-termvision and strategic commitment of the investors to the recipienteconomy. In contrast, FPI is intrinsically short-term aiming tomaximize risk-return payoffs from capital markets. While both FDI andFPI are reflected in capital structures of resident enterprises as equity

held by non-resident entities, FDI is distinguished by the investorsdesire to hold a controlling stake in the enterprise.3 In this respect,foreign investment policies of host economies usually refer to FDIpolicies with operational procedures for portfolio investment beingfunctionally inclusive aspects of such policies.

Indias present policy framework for inward FDI wasintroduced by the Industrial Policy Statement of July 24, 1991. Theframework has subsequently evolved and enlarged in line withreforms and structural developments in the economy. The presentpolicy allows foreign investors to invest in resident entities througheither the automatic route or the government-administered route.

Most sectors and activities qualify for the automatic route. This routeallows investors to bring in funds without obtaining prior permissionfrom the Government, RBI, or any other regulatory agency. However,invested enterprises are required to inform RBI within 30 days ofreceipt of funds and also comply with documentation requirementswithin 30 days of issue of shares to foreign investors.4

Certain investment intentions do not qualify under automaticroute and require prior permission from the government. There arealso sectors/activities where despite being eligible for automaticroute, foreign investment is subject to other caveats. A detailed

http://www.dipp.nic.in/manual/FDI_Manual_Latset.pdf [Accessed on June 2, 2009].3

Both IMF and OECD define FDI as investment for obtaining a lasting interest byresident entity of one economy in an enterprise that is resident in another economy.The lasting interest symbolizes a desire to exert significant influence in managerialcontrol of the invested enterprise. The IMFs Balance of Payment Manual (1993,5

thedition) defines a direct investor as one owning 10% or more of an enterprises

capital.' See Duce, M. and Espana, B. (2003), Definitions of Foreign DirectInvestment: A Methodological Note, July 31; See also http://www.bis.org/

publ/cgfs22bde3.pdf [Accessed on June 19, 2009]4

These apply to non-resident Indians (NRIs), Persons of Indian Origin (PIOs) andOverseas Corporate Bodies (OCBs) as well.


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illustration of these sectors and associated conditions is atAppendix 1. Appendix 1 also indicates extant restrictions on degree offoreign investment permitted in various sectors. Though almost all ofmanufacturing is fully open to foreign investment, limitations on extentof foreign ownership (measured by proportion of equity capitalbelonging to non-resident entities) prevail in several services. Most ofIndias agriculture is closed to foreign investment, while it is prohibitedin atomic energy, lottery business, gambling & betting and retailtrading (except single-brand retailing).

The present policy permits foreign investors to collaborate withlocal partners as well as establish wholly owned subsidiaries (WOSs).Both joint ventures and WOSs can be incorporated as residententerprises under the Indian Companies Act (1956). Foreign-ownedenterprises can also be unincorporated entities such asliaison/project/branch offices. Commercial scopes of unincorporatedentities, however, are narrower compared to their incorporated

counterparts.5

India does not restrict repatriation of investments, dividendsand profits. Non-resident investors can dispose equity shares withoutprior government permission. They are also allowed to purchaseimmovable property in India after acquiring permission for doingbusiness as incorporated/unincorporated entities.6 Such acquisition,however, needs to be brought to the notice of the RBI within 90 days.Furthermore, according to the Foreign Exchange Management Act(FEMA) of 2000, acquired property cannot be transferred withoutpermission of RBI.7

Other than funding new ventures, foreign investors canacquire stakes in existing resident companies. Equity transfer fromresidents to non-residents in such instances of mergers andacquisitions (M&A) is usually permitted under the automatic route.However, if the M&As are in sectors and activities requiring priorgovernment permission (Appendix 1) then transfer can proceed onlyafter such permission.

The foreign investment policy offers some additional benefitsto expatriate Indian investors (NRIs, PIOs and OCBs)8 includingpermission to invest more than the prescribed foreign equity ceilingsin specific sectors such as domestic scheduled passenger airlines,ground handling and cargo services where expatriates can invest up

to 100 percent under the automatic route as opposed to non-5

Liaison and project offices cannot carry out exclusive commercial activities exceptfor facilitating export-import business, technical/financial collaborations and activitiesincidental to projects. Branch offices, besides acting as buying/selling agents ofparent companies, can render consultancy services and research work. Source is ascited in 3 above, p. 24-25.6

Liaison offices cannot acquire immovable property.7

Refer Notification No. FEMA 21/2000-RB dated May 3, 2000.8

Companies or other entities owned directly or indirectly to the extent of at least60 percent by NRIs.


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expatriate investment ceiling of 49 percent.9 Expatriate investors alsoenjoy more liberal facilities with respect to transfer of immovableproperty acquired in India.

Short-term portfolio investors, primarily foreign institutional

investors (FIIs)10

, can invest in equity shares and convertibledebentures of resident enterprises. They, however, need to registerwith the Securities and Exchange Board of India (SEBI) - Indiascapital market regulator. FIIs can split capital portfolios in 70:30 ratiosbetween equity and debt. Though they can transact on notified stockexchanges without prior permission of RBI, individually, they cannotown more than 10 percent equity in paid-up capitals of Indianenterprises, while aggregate FII holding is capped at 24 percent. Inthis respect, the foreign investment policy shows a clear preferencefor longer-term FDI, which is allowed up to 100 percent in most areas,rather than short-term portfolio flows.

Small scale enterprises

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can attract FDI up to 24 percent oftheir total capital. Higher levels of foreign equity require theenterprises to surrender their small status. Small enterprises cannotremain small even if non-small domestic investors pick up morethan 24 percent of their capitals. Foreign investors seeking more than24 percent equity holding in enterprises manufacturing items reservedfor small industries require prior government approval. Infusion ofsuch equity also requires the small enterprise to obtain an industriallicense for continuing to produce items reserved for small industries.

Investing in Special Economic Zones (SEZs) attracts a slew ofincentives for foreign investors with such investments exempt frompractically all taxes, including those on export profit, capital gains,dividend distribution as well as customs duties on imported goodsand local excise. In addition, investments in specific segments ofinfrastructure such as roads, airports, seaports, inland waterways,sanitation and sewage systems, solid waste management, electricitygeneration, transmission & distribution and housing and hospitaldevelopment are eligible for full income-tax exemptions. India hasdouble tax avoidance agreement (DTAA) with 69 countries enablingforeign investors to choose their preferred taxation turfs.

9Press Note 7 (2008), Department of Industrial Promotion and Policy (DIPP),

Government of India. Available at: http://siadipp.nic.in/policy/

changes.htm [Accessed on June 3, 2009].10

FIIs include asset management companies (AMCs), pension and mutual funds,investment trusts, endowment foundations, university funds, charitable trusts andsocieties. Further details on portfolio investment scheme are available at source citedin 3 above, p. 32-33.11

An enterprise whose investment in plant and machinery does not exceedRs 10 million.


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Gradual Evolution

Indias approach to foreign investment during the 1950s and 1960swas cautiously pragmatic. It was ensured that ownership andenterprise control remained primarily with resident investors. Withinsuch limitations, foreign investment was sought to be utilized in amanner beneficial for the economy.

The official position on foreign investment was articulated in astatement12 made to the Constituent Assembly on April 6, 1949, by

Jawaharlal Nehru. Foreign capital was recognized as an importantsupplement to domestic savings for facilitating national economic andtechnological progress. Foreign investors were allowed full freedomof repatriation with the assurance of compensation in the unforeseenevent of nationalization.

Foreign investment proposals, however, were sanctioned onlyafter careful scrutiny necessitated by Indias fragile balance ofpayments (BOP) and scarce foreign exchange reserves. Authoritiesdid not wish to aggravate BOP difficulties given the unconditionalassurance of repatriation and foreign investment therefore waschannelized mostly into essential industries. The tight monitoring

ensured that there was hardly much FDI in the economy (except inthe oil sector) till the middle of the 1950s.

The situation changed from Indias 2nd Five-Year Plan (1956-1961) that awarded high priority to rapid industrialization. TheIndustrial Policy Resolution (IPR) of 1956 emphasized on increasingtechnological capabilities of indigenous industry for producing high-quality capital, intermediate and consumer goods. The thrust ontechnological self-reliance increased the importance of FDI with thelatter expected to be a key conduit for transfer of advancedtechnology. At the same time, while foreign exchange difficulties hadearlier forced rationing of FDI, aggravation of the same difficulties

increased its acceptance13

, as it was realized that foreign exchangeresources were inadequate for importing large-scale machinery andequipment for domestic industry. Foreign investment began to be

12See IIC (1965), India Welcomes Foreign Investment by India Investment Centre

(IIC), New Delhi; p. 7.13

Kidron, M. (1965), Foreign Investments in India, Oxford University Press (OUP),London.


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encouraged with fiscal incentives14 during the late 1950s and 1960swith foreign capital also allowed in industries reserved exclusively forthe public sector.15

The 1970s kicked off an inward-looking phase that led to

foreign investment getting heavily regulated. The scope of foreigninvestment was not only confined to industries requiring sophisticatedtechnology, but was accompanied by a deliberate attempt to divertFDI from consumer goods to capital and intermediate goods.16Restricting FDI was a part of efforts aiming to extend state control invarious sectors of the economy and was consistent with promulgationof restrictive legislations such as Monopolies and Restrictive TradePractices (MRTP) Act (1969), the Patent Act (1970) and alliedmeasures such as nationalization of banks, insurance companies andcoal mines.

The Industrial Policy Resolution (IPR) of 1973 limited foreign

participation to export-oriented industries that were strategicallyimportant for long term growth prospects of the country. The mostrestrictive controls were enforced through the Foreign ExchangeRegulation Act (FERA) of 1973. FERA consciously discriminatedbetween domestic and foreign investors making it mandatory forbranches and subsidiaries of foreign firms to convert foreign equitiesto minority holdings.17 There were, however, some exceptions suchas predominantly export-oriented firms, or those producing itemsrequiring sophisticated technology. But even these firms had to fulfillexport obligations by exporting certain minimum parts of their annualturnovers. The Industrial Policy Resolution (IPR) of 1977 furtherindicated industries where no foreign collaboration (financial or

technical) was considered necessary. Foreign companies, which hadalready diluted foreign ownership to 40 percent or less in line with theFERA, were assured treatment on par with their Indian counterparts.However, despite imposition of such sweeping controls, it isnoteworthy that no restrictions were imposed on remittance of profits,royalties, dividends and repatriation of capital.

The year 1991 marked a key transition in Indias foreigninvestment policy. The transformation was induced by thegovernments decision to encourage stable non-debt creating long-

14

These included concessional rates of dividend tax for foreign investors and

lowering of taxes on technical service fees and income from royalties.15

Phillips Petroleum of USA had a minority stake in Cochin Refinery Ltd. a publicsector undertaking. The International Telephone and Telegraphs Corporation of theUS also collaborated with the Government in a similar manner for manufacturingtelephone equipment. See IIC (1965), p. 9.16

Martinussen, J. (1998), Transnational Corporations in a Developing Country: TheIndian Experience, New Delhi, Sage.17

Section 29 of FERA dealt with branches of foreign companies in India and Indianjoint stock companies having foreign participation. The FERA stipulated: 1. Branchesof foreign companies were to convert to Indian companies with minimum 60% equityparticipation. 2. Subsidiaries of foreign companies were to reduce foreign equity to40% or less.


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term capital flows as a major source of funds for supplementingdomestic savings. This was a significant departure from the overtreliance on debt-creating flows during the 1970s and 1980s. Suchreliance was instrumental in creating structural imbalances in theeconomy that manifested in a serious balance of payments crisis in1991. The crisis precipitated a paradigmatic shift in the policyperspective on future development of the country resulting in reformsaiming to move away from a rigidly controlled, inward-looking, state-dominated economic framework to a decontrolled, outward-orientedand market-friendly system. The positive outlook towards FDI was akey part of this shift.

The foreign investment policy for a reforming Indian economywas articulated in the new industrial policy announced on July 24,1991. The latter differed significantly different from its predecessors inits emphasis on private entrepreneurship. Entry barriers to privateparticipation in different industries were sought to be removed by

reducing the scope of industrial licensing, restricting the public sectorto areas of vital national importance, and withdrawing severalprohibitions under the MRTP Act of 1969, which constrainedexpansion of industrial investment.

The industrial policy allowed foreign investment in thirty fivehigh-priority industries while removing several procedural controls oninflow of FDI.18 The policy introduced the automatic route for FDI.Sectors opened to FDI included almost the entire gamut ofmachineries (e.g. rubber, printing, electrical, industrial andagricultural), processed food, oil extraction, cement, metallurgicalindustries, chemical, ceramics, paper, fibres, pharmaceuticals,

fertilizers, automobiles & auto components, electrical equipment,hotels & tourism and software.19 The thrust was clearly on attractingforeign capital and technology in large segments of manufacturingwith FDI in services remaining restricted to tourism and software.

Easy entry of foreign capital in notified industries wasaccompanied by some limiting restrictions. Foreign ownership wascapped at a maximum of 51 percent of enterprise capital. Automaticapproval was contingent upon the proposed foreign equity coveringthe foreign exchange requirement for imported capital goods.

18Statement on Industrial Policy', July 24, 1991, paragraph 1.25 as reproduced in

Handbook of Industrial Policy and Statistics(2006-2007), Office of Economic Adviser,Ministry of Commerce and Industry, Government of India; p. 6; available at:http://eaindustry.nic.in/2008_handout.htm [Accessed on June 2,2009].19

Press Note No. 10 (1992 series), DIPP, Government of India; pp. 60-81; Availableat: http://siadipp.nic.in/policy/changes.htm [Accessed on June

2, 2009].


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Furthermore, companies receiving automatic approval for FDI up to51 percent were required to balance their dividend payments byexport earnings over a period of seven years.20

Entry of foreign investment was streamlined in two distinct

channels. Apart from the automatic route, an empowered Board wasset up for negotiating with investors and approving investments inselect areas. This board the Foreign Investment Promotion Board(FIPB) administers the government channel of foreigninvestments.21 Subsequent developments in FDI policy have focusedon altering the scale and scope of foreign investment between thesetwo routes.

Since 1991, FDI policies and procedures have beenprogressively relaxed at different points in time. A major policyrevamp occurred in February 2000. The automatic route wassignificantly expanded to make FDI in all items/activities eligible for

the route except a well-defined negative list. The latter includedindustries requiring licenses under the Industries (Development andRegulation) Act of 1951 and in terms of locational policy requirementsof the Industrial Policy of 1991, proposals involving FDI higher than24 percent of equity in small-scale enterprises, instances whereforeign collaborator had previous venture/tie-up in India, casesrelating to acquisition of shares in resident Indian companies in favorof foreign/NRI/OCB investors and all proposals falling outside notifiedsectoral policy/caps relating to the automatic route, or in sectorswhere FDI was not permitted. The negative list proposals were to beexamined by FIPB.

Liberalization of FDI policies has been a part of reformsaiming to remove controls on industrial output. A key reform in thisregard has been reduction of the scope of the public sector. Indiasindustrialization during the first four decades of its planneddevelopment was led by the public sector. Public enterprisesdominated the basic and heavy segments of manufacturing (e.g.steel, cement and coal). While consumer goods and intermediateshad sizeable presence of small and medium private enterprises, keyservices (e.g. electricity, telecommunication, road transport, aviation,shipping, banking, insurance) were monopolized by state agencies.Effective entry of foreign investors in the Indian economy wasinconceivable till the scope of the public sector was reduced and

private enterprise allowed to fill up the vacuum. The Industrial Policyof 1991 limited public sector monopoly to only eight activities while

20Source is as cited in 18 above; pp. 15-16.

21The FIPB is located in the Department of Economic Affairs, Ministry of Finance.

The Board includes Secretaries of the Department of Economic Affairs, Departmentof Industrial Policy & Promotion, Department of Commerce, Department of EconomicRelations, Ministry of External Affairs and Ministry of Overseas Affairs. The Board ischaired by the Secretary, Department of Economic Affairs. Source is as in 3 above;p. 55.


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freeing up the rest.22 Subsequently state monopoly has beencramped to only sectors of strategic importance such as atomicenergy. Private initiative and foreign investment has been allowed inmost of the erstwhile domain of the public sector including sensitivesegments such as defense, insurance, petroleum & natural gas.

Industrial licenses were widely perceived as critical entrybarriers for private enterprise. It was evident that mere opening up ofthe economy to foreign investment was unlikely to see suchinvestment materializing unless entry barriers were removed. Thuswhile limiting the public sector increased potential for competition,withdrawal of licensesfacilitated competition. The Industrial Policy of1991 confined mandatory licensing to 18 manufacturing industries.These included minerals and natural resource-based products,chemicals, alcoholic beverages, tobacco and consumer durables.23Licensing continued even in some high-priority industries madeeligible for FDI up to 51 percent through automatic route (e.g.

pharmaceuticals and automobiles). These were, however, freed soonafter. While automobiles were de-licensed in April 1993, most bulkdrugs and formulations were freed from licensing in 1994.24 Themeasures have yielded dividends with leading global automobileassemblers (e.g. Benz, Honda, Hyundai, Toyota) setting upproduction facilities in India and the pharmaceutical & biotechnologyindustries witnessing entry of major global players such asGlaxoSmithKline, Eli Lily, Monsanto and Wockhardt.

Progressive de-licensing has resulted in licensing now beingconfined to five activities: alcoholic beverages, electronic aerospaceand defense equipment, cigarettes & tobacco, industrial explosives

and hazardous chemicals.25

FDI is permitted in these industries,though proposals for manufacture of cigarettes and defenseequipment require clearance from the FIPB, while the remaining iseligible for the automatic route.

The industrial policy of 1991 justified entry of foreigninvestment by citing the intrinsic virtues of FDI such as advancedtechnology, proven managerial expertise and modern marketing

22These areas were arms & ammunition, atomic energy, coal and lignite, mineral

oils, mining of iron and manganese, mining of copper, lead, zinc and tin, mineralsspecified in the Schedule to Atomic Energy and railway transport.23 Coal & lignite, petroleum, alcoholic drinks, animal fats & oils, sugar, cigarettes &tobacco, asbestos, plywood and other wood-based products, raw hides & skins &leather, tanned and dressed fur skins, motor cars, paper and newsprint, electronicaerospace and defense equipment, industrial explosives, hazardous chemicals,drugs & pharmaceuticals, Entertainment electronics (e.g. television, tape recorders),white goods (refrigerators, washing machines, microwave ovens, air conditionersetc). See Annex II, Press Note No. 9 (1991 series), DIPP, Government of India,available at: http://siadipp.nic.in/policy/changes.htm [Accessedon June 3, 2009].24

Press Note No. 5 (1996) series, DIPP, Government of India; Source as in 23above.25

Source is as cited in 3 above, p. 14.


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techniques.26 New export possibilities were also underlined as one ofthe likely spin-offs from such investment. It was therefore natural thatFDI be initially allowed only in sectors where advanced technologyand other attributes could make a significant difference to industrialcapacities and competitiveness, both in domestic and overseasmarkets. More industries have been subsequently opened to FDI.Almost the entire sweep of manufacturing ranging from basic andcapital goods to intermediates and consumer durables are now opento foreign investment. But the across-the-board opening up inmanufacturing has not been accompanied by similar moves inservices and agriculture.

Over time Indias foreign investment policy has steadilyenlarged the scope of foreign ownership in resident enterprises. The1991 policy made a rather cautious beginning in this respect, whichwas fully in sync with the calibrated approach characterizing Indiaseconomic reforms. With FDI ceiling frozen at 51 percent, foreign

investors, while aspiring to become majority stakeholders, had to stillhave local partners and could not establish WOSs. Foreign equityremained capped at 51 percent for quite a few years and it was onlyin January 1997 that nine industries were allowed to increase FDI to74 percent27 under the automatic route. The bulk of the expanded listcomprised services including mining, electricity generation andtransmission, non-conventional energy generation and distribution,construction, land transport, water transport, storage andwarehousing. Only two industries basic metals & alloys and othermanufacturing industries were manufacturing.

In a significant move, 100 percent foreign ownership under

automatic route was allowed in electricity generation, transmission,and distribution in June 1998. However, the projects were capped ata maximum of Rs 15 billion (approximately US$300 million@1USD=Rs 50). Within less than a year in January 1999, projects forconstruction and maintenance of roads, highways, vehicular bridges,toll roads, vehicular tunnels, ports and harbours were permitted100 percent FDI under automatic route subject to same limitations onsize.28 Permission of full foreign ownership underlined the urgency ofinviting funds in Indias infrastructure. Since then, almost allmanufacturing activities and several services have been allowed toaccess 100 percent FDI under automatic route.

The gradual ease of entryenabled to foreign investors throughthe automatic route marks another key reform in Indias foreigninvestment policy. The automatic route is a simpler route than thegovernment-administered (FIPB) process. Since the latter involves

26Source is as cited in 18 above, p.11.

27Press Note No. 2 (1997 series), DIPP, Government of India; Source is as cited

in 23 above.28

Press Note No. 1 (1999 series), DIPP, Government of India. Source is as citedin 23 above.


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acquiring prior permission before the investor can bring in funds,there are more procedures involved entailing greater transactioncosts. For almost a decade, however, the scope of the automaticroute remained relatively restricted. It is interesting to note thatthough bulk drugs figured in Annexure III of the industrial policy of1991, which specified industries eligible for FDI under automaticroute, investment proposals in drugs continued to be guided byrestrictive provisions of the Drug Policy of 1986. It was only inOctober 1994 that FDI in bulk drugs, intermediates and formulationswere granted automatic approval.29 The coverage of the automaticroute remained restricted till January 1997, when thirteen newindustries were permitted FDI up to 51 percent under automaticroute.30 Ease of entry for foreign investors were greatly expanded inFebruary 200031 with FDI in all industries channelized to theautomatic route barring activities attracting provisions of the NegativeList mentioned earlier.

The scopes of the Negative List and intervention by FIPB havenarrowed over time. Much of the contraction has come fromincreases in FDI limits for automatic route as well as wider structuralfacilitations. A key step in this respect has been simplification of rulesrelating to foreign investment in instances where the investor had aprevious tie-up with a local partner. Foreign investors with previoustie-ups were required to justify why the new venture will not beinjurious to the existing collaboration.32 The current rules specify theonus of justification on both the foreign investor as well as the localpartner. All proposals of this nature now qualify under the automaticroute unless the proposed venture is exactly in the same field.33

The FIPB is also no longer required to decide on proposalspertaining to transfer and acquisition of resident shares by non-residents with the process now being delegated to the automaticroute.34 Indeed, except for segments where FDI has equity caps(Appendix 1) and the narrowly defined premise of new ventures in

29Press Note No. 4 (1994 series), DIPP, Government of India. Source is as cited

in 23 above.30

Same as in 27 above.31

Press Note No. 2 (2000 series), DIPP, Government of India. Source is as citedin 23 above.32

Press Note no. 18 (1998 series); DIPP, Government of India. Source is as cited

in 23 above.33

Press note no. 1 (2005 series); DIPP, Government of India. Source is asmentioned in 19 above.34

Press note No. 4 (2006 series); DIPP, Government of India. Source is asmentioned in 23 above. However, FIPBs approval is required for transfer of shares insectors where FDI is not permitted up to 100% under automatic route (Appendix 1).For all these industries, FIPB approval is required in instances where an Indiancompany is being incorporated with foreign funds and such a company is eitherowned/controlled by non-resident entities, or where ownership/control of Indiancompanies resting with resident Indian entities is being transferred to non-residententities on account of merger, amalgamation or acquisition. Press Note No. 3 (2009series), DIPP, Government of India. Source again is as in 23 above.


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fields where investors have existing collaborations, the FIPBs role isconfined to cases where investment proposals involve more than24 percent equity in small enterprises.


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(e.g. telecommunications, defense production, broadcasting, printmedia and satellite operations) have limitations on foreign ownershipand require government sanctions. Such concerns, however, shouldnot apply to agriculture. Nonetheless foreign investment can only bein a few value-additive agricultural activities like aquaculture,floriculture, pisciculture, horticulture, development of seeds, animalhusbandry and cultivation of vegetables and mushrooms. While theseare eligible for 100 percent FDI under automatic route, investment intea plantations is regulated by the FIPB and is subject to therestrictive condition of divestment of equity in favour of local partners(Appendix 1).

Closed policies for FDI in agriculture can partly be explainedon account of the latter figuring primarily in administrative domains ofstates. Article 246 in the Seventh Schedule of the Indian Constitutiondivides responsibilities between the central government (Union List),state governments (State List) and jointly between centre and states

(Concurrent List). This vests agriculture, water, and land with states37enabling state governments to frame their own policies in thesesubjects. On the other hand, external trade & commerce andindustries rest with the central government. The Constitutionalseparation of responsibilities implies that framing an overarchingforeign investment policy in agriculture requires close coordinationbetween individual states, as well as between the centre and states.Such coordination is difficult to achieve in a large and complex federaladministrative set-up like Indias. In addition, foreign investment inkey agricultural activities such as procurement is not possible unlessindividual states reform their marketing and procurement policies.

The fate of foreign investment in Indias agriculture will dependupon political management of domestic sensitivities. Severalsegments of Indias agriculture remain protected from imports. Thisinward-looking attitude seems to have influenced the outlook towardsforeign investment as well. Potential welfare gains (or losses)associated with greater market access to imports in a sector providinglivelihood to around two-third of the countrys population (despitecontributing only 17 percent of national output) is debatable.Nonetheless, resistance to market access and antipathy to foreigninvestment has overlooked the positive difference which suchinvestment can make to agricultural productivity and infrastructure.But given the political sensitivity associated with impacts of economic

policies on farming livelihoods, a circumspect approach to foreigngoods and capital looks set to prevail in the foreseeable future.

Service reforms have progressed far slowly than those inmanufacturing. Public services in India were state monopolies fordecades. Even now, rail transport, electricity generation, airports &

37Seventh Schedule (Article 246) of the Constitution of India, available at:

http://indiacode.nic.in/coiweb/fullact1.asp?tfnm=00%2051

1 [Accessed on June 4, 2009].


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seaports, banking and insurance have overarching state presence.Opening up most services to foreign investment had to be precededby domestic reforms enabling private entry and competition. Suchreforms took considerable time in sectors like electricity andtelecommunication due to efforts requiring establishment ofindependent regulators for creating appropriate incentive structuresfor private investment. With the exception of telecommunications,regulatory frameworks for most public services are still trying to cometo terms with the complex challenges arising from nascent growth ofcompetition in historically controlled territories.

Decisions relating to removal of industrial licenses and entry offoreign investment in manufacturing could be taken relatively easilysince both figured under the operational purview of the DIPP in theMinistry of Industry. However, foreign investment decisions inservices entailed extensive consultations between DIPP andindividual ministries in charge of specific services adding to delays in

arriving at decisions. Though the DIPP notifies policies on foreigninvestment in services, investment guidelines are usuallyaccompanied by specifications issued by nodal ministries. FDI inpower and airports, for example, despite being allowed up to 100percent under automatic route is subject to provisions of theElectricity Act of 2003 and departmental regulations of the Ministry ofCivil Aviation respectively.

Slow progress in domestic reforms in competition andregulation has resulted in FDI remaining restrictive in severalservices. These include domestic passenger airlines, FM radio andcable network services, publishing of newspapers and retail trading

(except single brand)38

. However, in services such astelecommunication and the internet, mining, road transport, electricityand non-passenger aviation services, FDI policies are more liberal(Appendix 1). Energy, road transport and mining were among theearliest to be opened up to foreign investment on account of pressinginvestment needs for augmenting capacities. Within financialservices, liberal policies for non-banking services are accompaniedby relatively restrictive regulations in insurance and banking.

Indias foreign investment regime has experienced a gradualpace of liberalization in line with the caution and calibrationcharacterizing Indias economic reforms. The latter have never been

overly aggressive. Measures to decontrol and introduce competitionhave usually been accompanied by conditions aiming to temper theinitial intensity of such competition. The earliest efforts to inviteforeign capital in July 1991 were accompanied by the dividendbalancing condition. The condition of foreign equity covering foreignexchange requirements for import of capital goods applicable toautomatic approvals for 51 percent FDI in high-priority industries was withdrawn much later. Similar moves in the later years pertain to

38NRIs can invest up to 100 percent in scheduled domestic passenger airlines.


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limitation on project sizes in electricity and road transport despiteallowing 100 percent FDI and minimum capitalization norms for non-banking financial companies (NBFCs). The caveats reflect cautionarising from concerns over maintaining stable levels of foreignexchange reserves as well as avoiding marginalization of domesticproducers in different segments.

Calibrated policy moves have been aimed at assuagingpolitical opposition as well. Introduction of economic reformsgenerated intense debates in an economy accustomed to decades ofcontrols and planned development. Controls had produced pressurelobbies enjoying political patronage and influence. Opposition toreforms were spearheaded by these segments, which includeddomestic producers benefitting from high import tariffs and entrybarriers like industrial licensing. Indeed, early moves to open upmanufacturing to FDI evoked a chorus of protests from many ofIndias leading industrialists popularly christened the Bombay Club

demanding a level playing field between domestic and foreigninvestors.39

In the years that followed, there were attempts to exploit theemotive imperial aspect of foreign investment by highlighting itsallegedly adverse effects on indigenous producers and industries.Agitations against foreign investment with pronounced nationalistichues and arguing for discrimination between domestic and foreigninvestors were led by organisations like the Swadeshi Jagaran Manch(SJM). The SJM was born in the early 1990s in response to Indiasefforts to globalize and is dedicated to fighting economic imperialismfor protecting indigenous industries. On the other hand, the Left

parties (e.g. Communist Party of India (CPI) and the CommunistParty of India (Marxist) (CPI-M) have been equally hostile to foreigninvestment. Their opposition stems from antipathy to privateinvestment per se and is an extension of the infant industryargument defending import-substitution and protectionist policies.

Political opposition to FDI has had a symbiotic associationwith interest groups with each trying to support the other on commongrounds. In telecom and finance, stakeholders earning rents frommonopolistic virtues could hardly be expected to supportcompetition, private entry and foreign investment. These specificallyinclude employee federations affiliated to mainstream political parties

and representing interests of Indias over-protected organized sectorworkers.40 Such groups are still active and resistant explaining why

39See a) Boquerat, G. (2003), Swadeshi in the Throes of Liberalization, inLandy, F.

and Chaudhuri, B.(eds.), Examining the Spatial Dimension: Globalization and LocalDevelopment in India, New Delhi, Manohar Publications and b) Thakore, D (1998),Congress More Likely to Sustain Liberalization, Business Commentary,February 26, available at: http://www.rediff.com/money/1998/feb/

26dilip.htm [Accessed on June 17, 2009].40

Indias labor market is characterized by dualism where stringent labour laws onexit in the formal organized sector co-exist with minimum regulations protecting


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Indias insurance sector which allowed maximum foreign ownership of26 percent way back in October 2000 has not experienced any furtherincrease in scope of such ownership after almost nine years and twodifferent governments.

The role of politically motivated pressure lobbies in restrictingFDI is best understood from the virulent opposition to foreign entry inretail trade. A modern, efficient and technologically advancedorganized retail industry has never been welcomed by Indias hugeunorganized retail trade. Such opposition has enjoyed covert politicalsupport given the significance of the 13 million strong smallunorganized retailers as a political constituency. In this respect therun-up to the latest Parliamentary elections held during April-May 2009 witnessed an interesting political consensus. Despite beingat opposite extremes of the ideological spectrum, election manifestosof the right-wing Bharatiya Janata Party (BJP) and the Left partieswere common in resisting foreign entry in retail.41 The rather

paradoxical similarity in agendas was clearly on account of bothviewing unorganized retail as a core constituency and advocatingprotectionist policies for safeguarding economic interests of smallretailers.

The success of the Congress-led coalition at the elections isunlikely to change the prospects of foreign capital in retail sincepolitical opposition continues to remain significant within thelegislature. A Parliament Committee has recently opined that foreignretail firms are likely to inflict significant welfare losses by creatinglarge-scale unemployment through predatory pricing policies.42Though this has not stopped Wal-Mart from commencing India

operations,43

any precipitate move to encourage further foreign entryin retail appears remote at this juncture. This is in spite of the latest

employee interests in the unorganized sector. See Kumar, Palit and Singh (2007),Sustainability of Economic Growth in India, Working Paper No. 25, Centre forInternational Governance Innovation (CIGI), May, available at:http://www.cigionline.org/sites/default/files/Paper%2025

_India.pdf [Accessed on June 21, 2009].41

Party manifestos seek to axe FDI in retail, Business Line, April 21, 2009, availableat: http://www.thehindubusinessline.com/2009/04/21/stories

/2009042151381500.htm [Accessed on June 16, 2009].42

House Panel Applies Brakes on FDI in retail, The Times of India, June 9, 2009,available at: http://timesofindia.indiatimes.com/articleshow/

msid-4632751,prtpage-1.cms [Accessed on June 16, 2009].43

Wal-Mart and Bharti Group opened their first cash and carry store in the city ofAmritsar in Punjab on May 30, 2009. Story available at:http://www.bloomberg.com/apps/news?pid=20601205&sid=a5IJ

nEEOESTo [Accessed on June 21, 2009].


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pre-budget Economic Survey of the Ministry of Finance making astrong pitch for FDI in multi-format retail, particularly in distribution offood items.44

Influential groups also continue to block entry of foreign capital

in broadcasting, print media and aviation. In these areas, as well as ineducation, legal and accountancy services, which till now have almostentirely inward-looking foreign investment policies, complexitiesinvolved in multilateral trade negotiations have also, influencedinvestment policies. Restrictions on foreign entry in these sectorshave been partly due to Indias unwillingness to offer deepercommitments in services negotiations on account of lukewarmresponses to its own demands for enhanced market accesselsewhere. Reluctance to offer deeper market access commitments,however, has often been influenced by domestic protectionistpressures.

Fortunately, Indias foreign investment policy has progressedin spite of political opposition and lobbyist pressures. This is primarilydue to favorable dispositions of key decision-makers towards foreigninvestment. In more recent times, however, political resistance isturning out to be more successful in blocking reforms than in the past.This could be due to the complex nature of the turfs where foreigncapital still has limited access. Agriculture, education, retail, media etcare sectors where policy consensus between centres and states adifficult mission to accomplish in the first place needs to be followedby effective coordination between central and state agencies.Reforms in many of these segments entail involvement of statelegislatures as well. Matters are not helped by management

compulsions of coalition politics, where minority partners holdconsiderable sway and can stall decisions on reforms and foreigninvestment.

44 Economic Survey 2008-2009; Box 2.6; p. 32, available at:

http://www.indiabudget.nic.in/es2008-09/chapt2009/

chap24.pdf [Accessed on July 2, 2009].


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Conclusion

While India has an overall market-friendly and liberal policy towardsforeign investment, foreign capital still does not enjoy equally porousaccess in all parts of the economy. Fairly unhindered access tomanufacturing is accompanied by conspicuous lack of access incertain services and agriculture. Indias future foreign investmentpolicy faces the critical challenge of increasing access of foreigncapital to these segments for enhancing inward FDI.

The existing pattern of inward FDI into India does point to thepossibility of substantive increase in investment following furtherliberalization. FDI inflows in India have been concentrating mostly inservices. Financial and non-financial services, computer software,telecommunications, housing and construction have been the topdrawers of FDI during April 2000 March 2009.45 The services-orientation of inward FDI vindicates arguments for greaterliberalization of foreign investment policies in services. Despite beingrelatively more restricted than manufacturing, Indias services aredrawing significant FDI due to undisputed virtues of large domesticmarket and skilled human resources. Manufacturing is unable to do

so in spite of more liberal entry rules primarily on account ofpersistence of high transaction costs arising from poor infrastructure,inflexible labor policies in the formal sector and opaque land markets.

Structural changes within the economy also point to a largerrole of foreign investment in some sectors. Insurance is a key area inthis respect. Rising life expectancy and greater healthcare costs haveincreased demand for a variety of life and non-life, equity market-linked insurance products. Global insurance majors with a diverseproduct portfolio can make a major difference in this regard.46 Indiasaviation industry, particularly the low-cost segment, can benefit fromforeign funds and managerial expertise at a time when it is strugglingto recover from financial difficulties. Indias agriculture, on the other

hand, is in dire need of investments for enhancing productivity and

45Fact Sheet on Foreign Investment; May 28, 2009; DIPP, Government of India; p. 2,

available at: http://www.dipp.nic.in/fdi_statistics/india_FDI_

March2009.pdf [Accessed on June 5, 2009].46

The Economic Survey2008-2009 argues for 100 percent foreign equity in specialinsurance companies providing all insurance products to rural residents and inagriculture-related activities. Otherwise, it favors increasing FDI cap to 49 percent ininsurance. Source is as in 45 earlier.


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Appendix 1

Indias Foreign Investment Policy:Sector-Specific Guidelines and Conditions

ForeignInvestment

Industry Condition

None Atomic EnergyGambling & bettingLottery businessRetail trading (except

single brand)Activities/sectors closed

to private investment

Foreign equityup to amaximum of26%

Broadcasting services

FM radio Equity limit is FDI & FIIcombined. RequiresFIPB approval and issubject to guidelines ofMinistry of Informationand Broadcasting

Up-linking of news andcurrent affairs TV channels

Equity limit is FDI & FIIcombined. RequiresFIPB approval

Print servicesPublishing newspapers andperiodicals on current affairs

Requires FIPBapproval

Defense industries Requires FIPBapproval

Insurance Equity limit is FDI & FIIcombined.


Broadcasting services

Hardware facilities Equity limit is FDI & FII

combined. RequiresFIPB approval and issubject to guidelines ofMinistry of Informationand Broadcasting

Cable network -Same as above-Direct-to-Home (DTH) -Same as above. FDI

limited to 20%


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Aviation servicesDomestic passenger airline47

Automatic route. Nodirect/indirectparticipation of foreigncarriers.

Financial services

Asset ReconstructionCompanies (ARCs)

No FII investment.Requires FIPBapproval

Credit InformationCompanies (CICs)

Equity limit is FDI & FIIcombined. FII limitcapped at 24% inlisted CICs. Investmentsubject to CIC(Regulation) Act, 2005.

Stock Exchanges Equity limit is FDI & FIIcombined. FDI and FIIlimits capped at 26%and 23% respectively.

Commodity Exchanges Equity limit is FDI & FIIcombined. FDI and FIIlimit capped at 26%and 23% respectively.FII purchases limitedto secondary marketswith no foreigninvestor/entity holdingmore than 5% equity.

Refining servicespetroleum and natural gas publicsector enterprises

Subject to guidelinesof the Ministry ofPetroleum and nodilution of equity inpublic enterprises


Distribution servicessingle brand retailing

Covers productsbranded atmanufacturing point.Products shouldbelong to a singlebrand and sold underthat brand globally.Requires FIPBapproval.

Foreign equityup to a

maximum of74%

Telecommunicationservices

Basic & Cellular Foreign equitybetween 49%-74%with up to 49% underautomatic route andFIPB approvalthereafter.

47NRIs allowed to invest up to 100%.


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Internet serviceproviders (ISPs) with gateways,radio paging & end-to-endbandwidth.

-Same as above-

Satellite establishment &

operation

Requires FIPB

approval.Financial services

private banksEquity limit is

FDI & FII combined.Under automatic route.

Aviation servicesnon-scheduled, cargo &chartered airlines, groundhandling services48

Under automatic route.Direct/ indirectparticipation of foreignairlines only in cargoservices. Subject toguidelines of civilaviation ministry.Ground handlingsubject to security

clearance.Foreign equityup to 100%with conditions

Aviation servicesairport development

Up to 74% underautomatic route andFIPB approvalthereafter.

Mining services Coaland lignite for captiveconsumption

Under automatic routesubject to provisions ofCoal MinesNationalization Act(1973)

Distribution servicesTrading of items sourced

from small scale industriesRequires FIPBapproval.

Test marketing of itemswith approval for manufacture

Requires FIPBapproval. Testmarketing approvalshould be available forminimum two years.Investment inmanufacturing shouldcommencesimultaneously withmarketing.

Courier servicesCarrying packages, parcels and

items not covered under theIndian Post Office Act (1898).

Requires FIPBapproval. Activities

exclude distribution ofletters49.Financial services

Non-banking financial activitieslike merchant banking,underwriting portfoliomanagement, investment

Under automatic routesubject to minimumcapitalization norms :

a.Fund- basedactivities: US$0.5

48As in 25 above.

49Responsibility of states under the Constitution.


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advice, financial consultancy,stock broking, assetmanagement, venture capital,custodial operations, factoring,credit rating, leasing and

finance, housing finance, foreignexchange broking, credit card,money changing, micro creditand rural credit.

million upfront for FDIup to 51% equity;US$5 million upfrontfor FDI between 51%-74%; US$50 million

(US$7.5 million upfrontand the balance over24 months) for FDIbetween 75%-100%.

b.Non-fundbased activities:US$0.5 million

c.100%operating subsidiariescan be established if25% equity is divestedto Indian entities overa period of time.

However, this isexempted if US$50million is brought in.Applies for jointventure companieswith 75% or less than75% foreign equity.Capital for minimumcapitalization shallcomprise ordinaryshares. Investmentprocess must complywith RBI guidelines.

Constructiondevelopment services housing,commercial premises, resorts,education institutions,recreational facilities, cityinfrastructure, townships50

Under automatic route;subject to:

a.Minimumcapitalization of US$10million for WOSs andUS$5 million for jointventures with funds tobe brought in within sixmonths ofcommencement ofbusiness.

b.Minimumarea of 10 hectares forserviced housing plotsand built-up area of50,000 sq m forconstructiondevelopment projectand any of the abovein case of combinationof projects.

50FDI is not permitted in real estate business.


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Original investmentcannot be repatriatedbefore 3 years fromminimumcapitalization. However

investor may exit earlyby FIPB approval51.

Telecommunicationservices a) ISPs withoutgateways, b) Infrastructureprovider of dark fibre, right ofway, duct space and c)electronic mail & voice mail

Automatic route up to49%. FIPB approvalbeyond 49%.Companies mustdivest 26% equity infavour of Indian publicif they are listed inother parts of theworld. Also subject tolicensing and security

requirements.Energy services

power tradingUnder automatic routesubject to provisions ofElectricity Act (2003).

Manufacture of cigars &cigarettes

Requires FIPBapproval and industriallicense.

Alcohol distillation andbrewing

Requires FIPBapproval and industriallicense.

Tea industry, includingplantations52

Requires FIPBapproval subject todivestment of 26%equity in favour ofIndian entities withinfive years.

Source: compiled from a) Foreign Direct Investment in India: Policies andProcedures, Government of India, available at: http://www.dipp.nic.in/

manual/FDI_Manual_Latset.pdf [Accessed on June 2, 2009] and b) PressNote 7 (2008,) dated June 16, issued by DIPP, Government of India, available at:http://siadipp.nic.in/policy/changes.htm [Accessed on June 3,2009].

51Exempted for NRIs and investments in Special Economic Zones (SEZs).

52FDI is not permitted in any other activity in agriculture or plantation.


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Centre Asie Ifri

Asie.Visions is an electronic collection devoted to Asia. Written byFrench and international experts, Asie.Visions deals with economic,strategic, and political issues. The collection aims to contribute to thepublic debate and to a better understanding of Asian issues.Asie.Visions is published in French and in English.

Recent publications:

Axel Berkofsky, Japan-North Korea Relations: (Sad) State of Playand (Sad) Prospects, Asie.Visions n17 June 2009.

Guangjin Chen, Development of Rural China in the 21st Century:Progress Made and Challenges Ahead, From the Perspective ofEconomic Freedoms and Social Rights, Asie.Visions n16 June2009.

Franoise Nicolas, The Global Economic Crisis: a Golden Opportunityfor China, Asie.Visions n15 June 2009.

Valrie Niquet, Public Action in China: From Decision-Making toImplementation, Asie.Visions n14 March 2009.

Gilles Boqurat, The Democratic Transition in Pakistan under Stress,Asie.Visions n13 February 2009.

Benot Cailmail, The Fall of a Hindu Monarchy: Maoists in Power inNepal, Asie.Visions n12 January 2009.

Hlne Le Bail, Shen Wei, The Return of the Brains to China: Whatare the Social, Economic, and Political Impacts?Asie.Visions n11 October 2008.

Julien Kita, Japanese ODA and Africa: Towards a ProfitablePartnership?, Asie.Visions n10 September 2008.

Laurence Henry, Indias International Trade Policy,Asie.Visions n9 September 2008.

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